Leveraged ETF labels deserve study: SEC

ProShare Advisors says labelling system for ETFs is ‘unworkable’

By

RonaldD. Orol

WASHINGTON (MarketWatch) — The nation’s top watchdog for the multi-trillion-dollar asset management industry on Wednesday said serious consideration should be given to a suggestion that exchange-traded-funds that are leveraged and employ derivatives should be labeled as something other than ETFs.

“I think that a classification approach described is very interesting and deserves serious consideration,” said Eileen Rominger, director of the Securities and Exchange Commission’s division of investment management at a Senate Banking Committee hearing. Read “ETF name game goes to Washington.”

Critics have raised concerns that a group of ETFs that employ leverage and derivatives strategies as risky for long-term retail investors and should not be labelled ETFs, in part, because their performance over long periods of time can be significantly different than the indexes they track.

These types of ETFs represent a small slice of the overall $1 trillion ETF industry. Most other ETFs allow investors to invest in a “basket” of stocks, commodities or track an index and can be traded like stocks on exchanges.

Rominger responded to comments made by Noel Archard, a managing director at BlackRock Inc.
BLK, -0.72%
Archard said that products employing leverage, significant derivatives or so-called “inverse” strategies should not be permitted to use the ETF label. So-called “inverse” ETFs seek to deliver the opposite of the performance of the index or benchmark they track.

He adding that these kinds of products could be called exchange traded instruments and that they are designed for professional or short-term investors and not for long-term retail investors.

“These products require a greater deal of disclosure and up-front work with clients for them to understand investment and structural risks and BlackRock believes that they should not be labeled ETFs,”Archard said.

Rominger said the agency is continuing a policy it announced in March 2010 to prohibit new ETFs that seek to make “significant” use of derivatives until the agency completes a broader review of how derivatives are used by the industry.

“Concerns about those funds with respect to our investor protection mission caused us to pause in the issuance of exemptive orders for new ETFs that wanted to use derivatives,” Rominger said.

She also pointed out that the SEC in 2009 put out an investor alert that raised concerns about long-term retail investors buying leveraged and inverse ETFs. The agency noted that their performance over longer periods of time -- over weeks or months or years -- can be significantly different than that of the underlying index or benchmark during the same period of time. Read the SEC investor alert

Michael Sapir, chief executive of ProShare Advisors, the largest provider of leveraged and inverse ETFs, said the classification system recommended by BlackRock is “arbitrary, anticompetitive and unworkable.”

“Our systems work on a disclosure basis and it works fairly well, and introducing a whole other overlay on that is going to be an extraordinary complicated process to come up with and at the end of the day isn’t going to work very well,” Sapir said in a telephone interview. “Each ETF has a risk profile and certain investing characteristics and to have some sort of system that says these things go into this bucket and these things go into this bucket is unworkable.”

He added that the vast majority of investors use the leveraged or inverse ETFs for short-term strategies.

The U.S. ETF assets have increased 14-fold in the past twelve years, growing from $66 billion in 1999 to $1 trillion today, according to IndexUniverse LLC. Read MarketWatch's ETF screener

Archard noted that ETFs that employ leverage and derivatives currently make up less than 10% of the ETF assets in the U.S. but he added that raised questions about the role of all ETFs in the marketplace.

The ETF market has increased, in part, because the funds are low-cost and they allow investors to do things that they aren’t allowed to do with mutual funds, such as selling short or employing leverage.

Critics of ETFs raise concerns that leveraged ETFs and inverse ETFs drive increased market volatility. However, IndexUniverse said that this segment of the market is small so its impact on the markets is tiny.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.